overview of brief exercises, exercises, …unieducation.yolasite.com/resources/chap011.pdf · brief...

Brief LearningExercises Objectives Skills

B. Ex. 11.1 Stockholders' equity 4B. Ex. 11.2 Stockholders' equity 4B. Ex. 11.3 Dividends on preferred stock 5B. Ex. 11.4 Dividends on common and

preferred stock5 Analysis

B. Ex. 11.5 5

B. Ex. 11.6 Book value 7 Analysis, communicationB. Ex. 11.7 Book value 7B. Ex. 11.8 Stock split 8B. Ex. 11.9 Treasury stock 4, 9B. Ex. 11.10 Treasury stock 4, 9

Skills

11.1 Form of organization 1–3 Analysis, communication11.2 Accounting terminology 1–9 Analysis11.3 Prepare equity section 4, 5 Analysis, communication11.4 4, 5 Analysis, communication

11.5 Analyzing equity 4–7 Analysis11.6 Preferred stock alternatives 5, 6 Analysis11.7 Reporting effects of transactions 4, 7 Analysis11.8 Computing book value 4–7 Analysis, communication11.9 Treasury stock transactions 9 Analysis, communication11.10 Effects of stock splits 8 Communication, judgment11.11 Treasury stock presentation 9 Communication, judgment11.12 Real World: Carnival Corp. 4 Analysis, communication

Authorized stock11.13 4, 9 Analysis, communication

11.14 Treasury stock and stock split 8, 9 Analysis11.15 Real World: Home Depot 4, 7

Analysis

Analysis, communication

Analysis, communication

AnalysisAnalysis, communication

Dividends on preferred & common

Analysis, communication, researchReading an annual report

Common stock and treasury stock

TopicExercises

CHAPTER 11STOCKHOLDERS' EQUITY:

Learning Objectives

PAID-IN CAPITAL

Topic

Analysis

Dividends on common and preferred stock

OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL THINKING CASES

AnalysisAnalysis

© The McGraw-Hill Companies, Inc., 2012Overview

Problems LearningSets A, B Objectives Skills11.1 A,B Reporting stockholders’ equity 4, 5, 6 Analysis, communication11.2 A,B Reporting stockholders’ equity 4, 5, 6 Analysis, communication11.3 A,B Reporting stockholders’ equity 4, 5, 6 Analysis, communication11.4 A,B Comprehensive equity problem 4, 5 Analysis11.5 A,B Analysis of equity 4, 5 Analysis11.6 A,B Comprehensive equity analysis 1–7

11.7 A,B Par, book, and market values 4, 7 Communication, judgment11.8 A,B 4, 5, 7, 9 Analysis, communication

11.9 A,B 4, 5, 7, 8, 9

11.1 5, 7 Communication, judgment

11.2 7 Communication

11.3 1, 2, 3 Communication, judgment

11.4 1, 2, 3

11.5 Real World: Staples, Inc. 4, 5, 7, 9 Communication, technologyStockholders' equity items(Internet)

Communication, judgment, technology

Securities & Exchange Commission(Ethics, fraud & corporate governance)

Analytical, communication, group

Comprehensive equity with treasury stock transactionsComprehensive equity with treasury stock transactions and stock splits

Analytical, communication, judgment

Factors affecting market prices of preferred and common stocks

Selecting a form of business organization

Topic

Critical Thinking Cases

Factors affecting market prices of common stocks

Real World: McDonnell Douglas, Inc., Boeing, Citicorp, Ventitex, Inc.

© The McGraw-Hill Companies, Inc., 2012Overview (p.2)

DESCRIPTIONS OF PROBLEMS ANDCRITICAL THINKING CASES

Problems (Sets A and B)11.1 A,B

11.2 A,B

11.3 A,B

11.4 A,B

11.5 A,B

11.6 A,B

11.7 A,B

35 Strong

35 Medium

Waller Publications/Banner PublicationsA second short problem requiring the completion of the stockholders’ equity section of a corporate balance sheet. Includes preferred stock dividends and conceptual issues pertaining to dividends in arrears.

A more difficult problem involving distinction among par values, book values, and market values.

Parsons, Inc./Toasty Corporation

Manhattan Transport Company/Ray Beam, Inc.

A straightforward discussion of the relationships (if any) among par value, book value, and market value per share. A company has a book value 6,500 times greater than its par value, and a market value 65,000 times as high. Fun problem that makes a point.

A more difficult problem requiring the completion of the stockholders’ equity section of a corporate balance sheet. Includes preferred stock dividends and conceptual issues pertaining to equity versus debt financing.

Barnes Communications, Inc./Markup, Inc.A short but comprehensive problem on corporations. Includes journal entries for issuance of common stock and preferred stock. Also includes dividends on preferred stock, closing entries, and the preparation of the stockholders’ equity section of a corporate balance sheet.

Smithfield Products/Manor, Inc.

Analysis of the stockholders’ equity of a publicly owned corporation. Includes a discussion of why a business may opt to become publicly owned and the reasons why the dividend yields on preferred stocks vary.

A short problem requiring the completion of the stockholders’ equity section of a corporate balance sheet. Includes preferred stock dividends and conceptual issues pertaining to the market price of preferred stock.

Below are brief descriptions of each problem and case. These descriptions are accompanied by the estimated time (in minutes) required for completion and by a difficulty rating. The time estimates assume use of the partially filled-in working papers.

20 Easy

20 Easy

25 Medium

35 Medium

15 Easy

Robbinsville Press/Septa, Inc.

Techno Corporation/Brain Corporation

© The McGraw-Hill Companies, Inc., 2012Description Problems

Problems (continued)Feller Corporation/Tin Corporation

Herndon Industries/Parker Industries

Critical Thinking Cases

Factors Affecting the Market Prices of Common Stocks

Selecting a Form of Organization

S.E.C. Enforcement DivisionEthics, Fraud & Corporate Governance

Examining Stockholders' EquityInternet

*Supplemental Topic, “Special Types of Liabilities.”

11.9 A,B

15 Medium

11.2 25 Strong

11.3

30 Easy

11.8 A,B

Interview; No time estimateStudents are to interview the owners of two small businesses with

different forms of organization and find out why the particular form was selected—and if they have any misgivings.

15 MediumA stockholders’ equity problem involving paid-in capital from treasury stock transactions. Requires the computation of book value per share and reporting for the statement of cash flows.

A comprehensive equity problem involving treasury stock transactions in two different years, preferred and common stock transactions, book value calculations, and an understanding of stock splits.

11.1

30 Strong

11.4

11.5

Students are asked to identify and discuss elements of stockholders’ equity appearing in the balance sheet of Staples, Inc.

Factors Affecting the Market Prices of Preferred and Common Stocks

20 Easy

Students are asked to explain whether the prices of preferred stock, common stock, and convertible preferred stock are likely to rise or fall if profitability increases dramatically and interest rates rise slightly. A problem that stimulates lively classroom discussion.

Students are to explain the reason for changes in the market prices of stocks of various real companies. A difficult problem that is very thought-provoking.

Students do an internet search to locate the website of the Securities & Exchange Commission and respond to questions about the S.E.C.

© The McGraw-Hill Companies, Inc., 2012Desc. of Cases

SUGGESTED ANSWERS TO DISCUSSION QUESTIONS

1.

2. a.

b.

c.

d.

3

4.

5. a.

b.

Federal taxation on income. A corporation is subject to federal income tax on its income, and stockholders are also subject to a personal income tax on any amounts they receive as dividends. A sole proprietorship is not a taxable entity, but the owner must pay personal taxes on the income earned by the business, whether or not it is actually withdrawn by the owner.

Large corporations are often said to be publicly owned because they are literally owned by the general public. The capital stock of many large corporations is actively traded on organized stock exchanges, such as the New York Stock Exchange. Anyone may purchase an ownership interest in such corporations, even if that interest is but a single share of capital stock. Many large corporations have hundreds of thousands, even millions, of individual stockholders.

Owners’ liability for debts of the business. Sole proprietors are personally liable for the debts of the business. A corporation, however, is responsible for its own debts; the stockholders of a corporation are not personally liable for the debts of the business entity. Thus, the amount of money that a stockholder might lose by investing in a corporation is limited to the amount of his or her investment.

Transferability of ownership interest. A sole proprietor generally must sell his or her entire interest in the business. This creates a new business owned by a new sole proprietor. Shares of stock in a corporation are freely transferable.

Continuity of existence. A sole proprietorship is terminated upon sale or abandonment by the owner and upon that person’s death or incapacitation. Corporations continue in existence regardless of changes in ownership.

Paid-in capital of a corporation represents the amount invested by stockholders and is generally not available for dividends. Retained earnings represents the cumulative amount of net income not distributed to shareholders as dividends. The distinction between paid-in capital and retained earnings is useful because it shows how much of the total stockholders’ equity represents investments by the owners and how much has been accumulated through profitable operations since the company started in business.

Par value represents the legal capital per share, that is, the amount below which stockholders’ equity cannot be reduced except by losses. The primary significance of par value is that a corporation cannot declare a dividend if this action would reduce total stockholders’ equity below the par value of the outstanding stock.

Par value is not an indication of a fair market price for a share of stock. The market price of stock is determined by such factors as the profitability and solvency of the issuing company, interest rates, the amount of dividends paid by the stock, and general market conditions. The market price of a share of stock may be above or below its par value.

Cumulative means that unpaid dividends on preferred stock are carried forward and must be fully paid before any dividends can be paid on common stock.

Convertible means that each share of preferred stock may be returned to the corporation in exchange for a given number of shares of common stock under specified conditions.

© The McGraw-Hill Companies, Inc., 2012Q1-5

6.

7.

8

9. a.

b.

10.

11.

A change in the market price of IBM’s outstanding shares of capital stock has no effect upon IBM’s balance sheet. These shares belong to IBM’s stockholders, not to IBM. Therefore, a change in the market value of these shares has no effect upon the recorded amounts of IBM’s assets, liabilities, or stockholders’ equity. IBM’s paid-in capital accounts will continue to show the amount received by IBM at the time the capital stock was issued. This historical amount is not affected by subsequent changes in market price.

The purpose of a stock split is to reduce the per-share market price of the company’s stock down to a more appropriate “trading range”—that is, a price that is appealing to a greater number of potential investors.

Book value per share represents the amount of net assets (or stockholders’ equity) associated with each share of common stock. It is determined by dividing the total stockholders’ equity in the corporation, less the amount assigned to preferred stock (par value, or liquidation value if given, plus dividends in arrears) by the number of common shares outstanding. Book value does not represent the amount common stockholders would receive in the event of liquidation. If a corporation were liquidated, many assets would be sold at prices different from their carrying values in the accounting records. The resulting gains or losses would cause stockholders’ equity to change accordingly.

Noncumulative preferred stock is entitled to dividends only if and when they are declared. If noncumulative preferred dividends had not been declared for several years, it would be possible to declare only the current year’s dividends on preferred and then declare a dividend on common. Noncumulative preferred stock does not have the protection afforded by the cumulative requirements that any dividends in arrears must be paid before dividends can be paid on common. This means a weak form of dividend preference, and as a result the noncumulative feature is not attractive to most investors.

(a) Cash is classified as an asset; (b) Organization Costs typically are classified as an expense; (c) Preferred Stock, (d) Retained Earnings, and (e) Additional Paid-in Capital are all classified as stockholders’ equity accounts; (f) Income Taxes Payable is classified as a liability.

When a corporation obtains a bank loan there is no effect upon book value per share of common stock. Assets and liabilities both increase by the amount of the loan. Net assets, therefore, are unchanged.

Declaration of a dividend reduces book value per share. Total assets are not affected by the declaration of a dividend, but liabilities are increased. Net assets (stockholders’ equity), therefore, are decreased.


12.

13.

IncreaseDecreaseIncreaseNone*

15.

14.

Include preferred stock—Preferred stock offers investors an opportunity to invest on what may be a more predictable and secure basis than common stock. While dividends are not guaranteed, they are more predictable than on common stock, particularly for a new company. Some investors may be willing to invest in preferred stock while they would not be willing to accept the greater uncertainty and risk of common stock. This may be a factor in designing the company’s capital structure in light of the capital requirements of the new company.

Do not include preferred stock—The presence of preferred stock may make common stock less attractive in light of the dividend preference of preferred stock. Once the company is up and running, preferred stock may be undesirable in terms of the long-term capital structure of the company.

Features of preferred stock—Assuming preferred stock is included in the capital structure, the most important decision is whether the dividend is cumulative. If the dividend is cumulative, the preferred stock is more attractive to investors, but it detracts from the attractiveness of the common stock. The lack of the cumulative feature may make preferred stock a relatively weak investment alternative and effectively defeat the purpose of including preferred stock in the capital structure.

Sale of treasury stockStock split*A stock split increases the number of shares of stock and lowers the market price of that stock, but does not affect the total amount of paid-in capital.

No definitive answer can be given to this question because a case can be made for having preferred stock and for not having preferred stock. Similarly, if preferred stock is included in the capital structure, a case can be made for different features, primarily whether the dividend is cumulative or not.Following are comments under different assumptions about the desirability of preferred stock.

Treasury stock is corporate stock that has been issued and then reacquired by the issuing company.

One reason for acquiring treasury stock is to have stock available to issue to officers and employees under profit-sharing agreements, stock options, or bonus plans. Purchases of treasury stock may also be intended to support the market price of the stock or to increase earnings per share.

Treasury stock is not an asset; it represents a reduction in the amount of stockholders’ investment in the corporation. For this reason the cost of the treasury shares is reported in the balance sheet as a reductionof the stockholders’ equity.

Purchase of treasury stock

The purpose of this rule is to protect corporate creditors, for whom stockholders’ equity represents the margin of safety against loss from a shrinkage of asset values. The restriction of retained earnings for dividend purposes to the extent of the cost of treasury shares assures creditors that the stockholders’ equity of a corporation will not, as a result of the purchase of treasury shares, be reduced below the amount of paid-in capital. If this restriction were not imposed, a corporation might distribute assets equal to the entire amount of its retained earnings as dividends, and then distribute additional assets in payment for shares of its own stock, thereby reducing the net assets of the corporation below the amount of the paid-in capital or even below the amount of stated (legal) capital.

The major types of transactions and activities that change the amount of paid-in capital and the direction of that change are as follows:

Direction of changeTransaction/activitySale of capital stock


$100,00030,000 75,000

$205,000

B.Ex. 11.2 $100,000250,000

10,00020,000

100,000$480,000

B.Ex. 11.3

$1,800,000

B.Ex. 11.4 $200,000

120,000$80,000

B.Ex. 11.5 $120,000

80,000$40,000

$0.40

10,000 x $100 par x 8% x 4 years = $320,000

Dividends available for common stockDividends per share on common stock: $40,000/100,000 shares

If the preferred stock is cumulative, the entire dividend goes to preferred stock and the common stockholders will receive none of the $120,000 dividends declared. In fact, satisfaction of the full claim of the preferred stockholders in this case will require $320,000, determined as follows:

Preferred stock (1,000 shares @ $100)Common stock (10,000 shares @ $25)

Common stock (10,000 shares @ $2)Retained earnings

Dividend requirements for noncumulative preferred stock:

B.Ex. 11.1 Common stock (10,000 shares @ $10)

Dividends available for common stock

Total dividend declared

Additional paid-in capital (10,000 shares @ $3)Retained earnings Total stockholders' equity

Dividends on arrears on preferred stock for three years are calculated as follows:

100,000 shares x $100 par value x 6% dividend rate x 3 years =

10,000 x $100 par x 8% x 1 year

Total stockholders' equity

Additional paid-in capital: Preferred stock (1,000 shares @ $10)

The amount of dividends in arrears must be disclosed in the financial statements, but they are not formally included as a liability in the balance sheet until declared by the Board of Directors of the company.

Total dividend declaredDividend requirements for preferred stock: 10,000 shares x $100 par x 6% x 2 years

© The McGraw-Hill Companies, Inc., 2012BE11.1,2,3,4

B.Ex. 11.6

$23.50

B.Ex. 11.7$11,550,000

$4,000,000200,000 4,200,000

$7,350,000Book value per share of common stock:

$7,350,000/500,000 shares $14.70

B.Ex. 11.8

B.Ex. 11.9 $1,000,000

1,500,000$2,500,000 (550,000)$1,950,000

B.Ex. 11.10 $25,000,000

5,000,000

350,000$30,350,000 1,500,000$28,850,000

Total stockholders' equityLess: Treasury stock (10,000 shares x $55)

The book value on common stock is calculated by adding all stockholders' equity accounts together and dividing by the number of shares of common stock outstanding:

Total stockholders' equity ($4,000,000 + $5,000,000 + $800,000 + $1,750,000)

The stock split will double the number of shares outstanding from 100,000 to 200,000. It will reduce the market price of the stock to approximately half of its current price: $50 x 1/2 = $25. The split will have no impact on the total stockholders' equity attributable to common stock. While the number of shares will double, the par value will be reduced to half, or $5 per share, leaving the total stockholders' equity attributable to common stock unchanged.

Common stock (100,000 shares @ $10)

Amount attributable to common stock

($1,000,000 + $750,000 + $600,000)/100,000 shares =

This amount does not reflect the current market value of the stock. Instead, it reflects a per-share amount of the assets, less liabilities, included in the company's balance sheet.

Less: Preferred stock at par value Dividends in arrears (40,000 shares x $5)

[70,000 shares x ($55 - $50)]

Less: Treasury stock (30,000 shares x $50) Total stockholders' equity

Common stock (1,000,000 shares @ $25)

Additional paid-in capital on treasury stock

Additional paid-in capital on common stock(1,000,000 shares @ $5)

Additional paid-in capital(100,000 shares @ $15)

© The McGraw-Hill Companies, Inc., 2012BE11.6,7,8,9,10

Ex. 11.1 a. (1)

(a)(b)

(a)(b)

(2)

(a)(b)(c)

(a)(b)

b.

Ex. 11.2 a.b.c.

d.e.

f.g.h.i.

j.

SOLUTIONS TO EXERCISES

Advantages:

Organizing the scuba diving school as a sole proprietorship.

Easy to formNo double taxation on distributed earnings

Disadvantages:

Advantages:

Organizing the scuba diving school as a corporation.

Disadvantages:Double taxation on distributed earningsGreater regulation

A corporation would probably be the better form of organization because of the characteristic of limited liability of the owners. Potentially, a scuba diving student could be seriously injured in the class. With the sole proprietorship form of organization, your personal assets would be at risk to pay for the person’s injuries, after you exhausted any insurance coverage and assets that the business might have.

Common stockNone (Dividends in arrears are prior years’ dividends owed to holders of cumulative preferred stock.)

Personal liability of owner for debts of the businessBusiness ceases with death of owner

None (Retained earnings is not an amount of cash; it is an element of owners’ equity.)

Double taxationMarket value

No personal liability of owners for debts of the businessReadily transferable ownership sharesContinuous existence

None (The price of preferred stock varies inversely with interest rates.)

Publicly owned corporationPaid-in capitalRetained earningsNone (Book value is common stockholders’ equity divided by the number of common shares outstanding.)

© The McGraw-Hill Companies, Inc., 2012E11.1,2

Ex. 11.3 a.

$ 250,000

140,000

7,500770,000

$ 1,167,500 382,000

$ 1,549,500

b.

$736,000

$360,000 180,000$540,000

96,000 636,000$100,000

b.

c.

Ex. 11.5 a.

b.

c.

d.

Additional paid-in capital:Preferred stock ……………………………………………………

Common stock ($100,000 ÷ 400,000 shares) ……

Ex. 11.4 a.Dividends on 9% cumulative preferred stock:Total dividends paid in third year ………………………………………

Dividends on common stock in third year …………………………………

$ 0.25 per share

$ 13.50 per share

Common stock ……………………………………………………

Dividends per share:

Current year’s dividend ($100 x .12 x 8,000) ……………

Total paid on 9% cumulative preferred stock ……

Dividends on 12% noncumulative preferred stock:

Total paid-in capital ……………………………………………………Retained earnings ………………………………………………………

Stockholders’ equity:8% cumulative preferred stock, $100 par value,5,000 shares authorized, 2,500 shares issued and outstanding ………Common stock, $2 stated value, 100,000 shares authorized,70,000 shares issued and outstanding……………………………………

Preferred stock, 12% noncum. ($96,000 ÷ 8,000 shares)

Total stockholders’ equity …………………………………………

Dividends ($50 x .09 x 40,000 x 2 years) ………….Current year’s dividend ($50 x .09 x 40,000) …………

No. The market value of a corporation’s stock has no effect on the amount in the financial statements. Capital stock is recorded at the amount for which it was originally issued.

$ 12.00 per share

Preferred stock, 9% cum. ($540,000 ÷ 40,000 shares) …

$35,000,000 legal capital ($15,000,000 preferred, plus $20,000,000 common)$79,000,000 total paid-in capital ($35,000,000 legal capital, plus $44,000,000 additional paid-in capital)

The stockholders’ equity section of the balance sheet reports no additional paid-in capital. Thus, the preferred shares must have been issued at their respective par values ($50 per share for the 9% cumulative preferred stock, and $100 per share for the noncumulative preferred stock).

150,000 shares ($15,000,000 total par value, divided by $100 par value per share)

$1,050,000 ($15,000,000 total par value x 7% or 150,000 x $100 x 7%)

$16 [($20 million par value + $44 million additional paid-in capital) ÷ 4,000,000 shares issued]

© The McGraw-Hill Companies, Inc., 2012E11.3,4,5

e. $ 143,450,000 15,000,000

$ 128,450,000 4,000,000

$32.11

f.

Ex. 11.6

a. $50,000 (14,000)$36,000

b. $50,000

$14,000 14,000 (28,000)

$22,000

Current Stockholders’ Net Assets Equity Income

a. I I NEb. NE NE NEc. D D NE

I

Amount to common stock ……………………………………………

NED

Net Cash Flow(from Any

In arrears ……………………………………………

Total stockholders’ equity ……………………………………………Less: Par value of preferred stock (150,000 shares x $100) …………Equity of common stockholders ………………………………………Common shares outstanding …………………………………………

Total dividend …………………………………………………………Amount to preferred stock ……………………………………………Amount to common stock ……………………………………………

Ex. 11.7

Event

Book value per share ($128.45 million ÷ 4 million shares) …………

No. Changes in the market value of capital stock do not directly affect a corporation’s financial position and are not reflected in the equity section of the balance sheet.

Annual dividends on the preferred stock are $14,000 (7,000 × $25 × 8%)

Total dividend …………………………………………………………Amount to preferred stock:

Current year …………………………………………

Source)


Ex. 11.8 a.200,000$ 300,000 452,800 952,800$ 146,800 806,000$

b.806,000$

216,000 590,000$ 60,000

9.83$

c.

Ex. 11.9 a. Feb. 10 425,000Cash ………………………………………………… 425,000

June 4 198,000Treasury Stock …………………… 150,000 Additional Paid-in Capital: ………Treasury Stock…………………….. 48,000

Dec. 22 88,000

12,000Treasury Stock …………………… 100,000

c.

Sold 6,000 shares of treasury stock, cost $150,000, for $33 per share.

Cash …………………………………………

Cash ………………………………………

No, a restriction on retained earnings does not affect the total amount of retained earnings reported in the balance sheet. A restriction of retained earnings is disclosed, but does not reduce the total amount of retained earnings of a company. The restriction on retained earnings simply limits the amount of dividends the corporation can pay as long as it holds treasury stock.

b. Restriction of retained earnings for treasury stock owned at year-end:$175,000 (7,000 shares still owned x $25 per share cost).

Sold 4,000 shares of treasury stock, cost $100,000, for $22 per share.

Total paid-in capital ………………………………………………Less: Deficit ………………………………………………………………Total net assets (stockholders’ equity) ……………………………………

No. The book value per share represents the stockholders’ share of the net book value of the corporation’s assets, not the assets’ liquidation values. The stockholders may receive more or less than the book value per share if the corporation is liquidated, depending primarily on the amounts at which the corporation’s assets are sold.

Treasury Stock ……………………………

Number of shares of common stock outstanding ………………………

Net assets (stockholders’ equity):8% cumulative preferred stock …………………………………………Common stock, $5 par, 60,000 shares issued ……………………………Additional paid-in capital …………………………………………………

Purchased 17,000 shares of treasury stock at $25 per share.

Additional Paid-in Capital: Treasury Stock …………………………………………

Book value per share of common stock:

Equity of common stockholders …………………………………………

Book value per share ($590,000 ÷ 60,000 shares)

Total stockholders’ equity (from part a ) ………………………………Claims of preferred stockholders ($200,000 plusLess:dividends in arrears, $16,000) ………………………………


Ex. 11.10 a.

b.

c.

Ex. 11.11 a.

b.

Ex. 11.12 a.

b. Authorized, but unissued, shares do not represent an asset of the company. At some time in the future they may result in an increase in assets if they are issued for cash or other assets, but until that time they simply represent the potential for future increases in assets. They are not included in the company’s balance sheet, other than through disclosure of the numbers of authorized and issued shares. This permits the reader of the financial statements to calculate the number of authorized, but unissued shares, as was done above.

Had the stock been split 2-for-1, it would begin trading at approximately $40 per share immediately after the split ($80 ÷ 2 = $40).

Had the stock been split 4-for-1, it would begin trading at approximately $20 per share immediately after the split ($80 ÷ 4 = $20).

When the market price of a corporation’s common stock appreciates in value significantly, as it had in the case of Fido Corporation, it may become too expensive for many investors. Thus, the decision to split the company’s stock was probably made with the intent of making it more affordable to investors.

Companies sometimes purchase shares of their own common stock to help boost the market price per share. This practice is not generally considered unethical, given that information pertaining to the purchase is fully disclosed in the company’s financial statements. Furthermore, if the company acquires a significantly large amount of its outstanding stock, the event would be reported in the financial press.

For a company to classify its treasury stock as a short-term investment is not appropriate. When treasury stock is purchased, the corporation is actually reducing its assets (cash), and eliminating part of its stockholders’ equity. For this reason, treasury stock should not appear in the balance sheet as a current asset.

Carnival Corporation could sell approximately 1,340 million additionalshares. This figure is determined by subtracting the number of issued shares from the number of authorized shares 1,960 million – 620 million = 1,340million.

© The McGraw-Hill Companies, Inc., 2012E11.10-12

Ex. 11.13 a. 6,600,000 5,500,000

1,100,000

4,400,000 4,000,000

400,000

2,400,000 2,400,000

b.

$4,000,000

5,500,000$

400,000 1,100,000

Total paid-in capital $11,000,000

Less: Treasury (common) stock at cost, 40,000 shares (2,400,000)

Total stockholders' equity $8,600,000

Additional Paid-in Capital on Preferred Stock…………………………………………..

Treasury Stock/Common (40,000 x $60)………….

Additional paid-in capital:

Common stock, $10 par value, 1,000,000 shares authorized, 550,000 shares issued

Preferred stockCommon stock

Cash (550,000 x $12)………………………………Common Stock (550,000 x $10)……………Additional Paid-in Capital on Common Stock………………………………………….

Preferred stock, 6%, $100 par value, 50,000 shares authorized, 40,000 shares issued and outstanding

Stockholders' Equity:

Cash……………………………………………

Note: No entry is required to record the authorization to issue preferred and common stock.

Cash (40,000 x $110)………………………………Preferred Stock (40,000 x $100)……………

© The McGraw-Hill Companies, Inc., 2012E11.13

Ex. 11.14 a. $1,000,000

800,000

30,000

$1,830,000

120,000

$1,950,000

(300,000)

$1,650,000

Calculations:Additional paid-in capital on common stock:

100,000 shares x ($18 - $10) = $800,000Additional paid-in capital on treasury stock:

10,000 shares x ($23 - $20) = $30,000Treasury stock:

15,000 shares x $20 = $300,000

b.

Common Stock, $10 par value, 200,000 shares authorized, 100,000shares issued

Total paid-in capital and retained earnings

Additional paid-in capital on common stock

Additional paid-in capital on treasury stock

Retained earnings

Transactions

Total paid-in capital

After a 2:1 stock split is distributed, the par value of the common stock will be reduced to half ($10 x 1/2 = $5) and all of the share numbers will double. The 2:1 split has no effect on the total figures for common stock, additional paid-in capital, retained earnings, treasury stock, or total stockholders' equity.

Less: Treasury stock

Total stockholders' equity


Ex. 11.15 a.

b.

c.

The par value is $.05 per share. The common stock originally sold above par value because the paid-in capital in excess of par value is large. In fact, it is over 73 times the par value of the shares that have been issued.

The number of authorized shares of common stock is 10 billion. Authorized shares are the number of shares specified in the company’s articles of incorporation. It represents the maximum number of shares that the company is authorized to issue by its state of incorporation.

$19,393 million. This amount is not how much the outstanding stock is actually worth. The total stockholders’ equity figure represents the amount invested in the company by owners over time, plus the amount of earnings retained in the company. The amount reported is an historical concept that may or may not bear a close relationship to the stock's current market value.


20 Minutes, Easy

a.

Stockholders' equity

authorized 100,000 shares, issued and outstanding 1,000,000$ 10,000 shares

issued and outstanding 170,000 shares 170,000

2,380,000 Total paid-in capital 3,550,000$

255,000 Total stockholders' equity 3,805,000$

1,085,000$ $ 320,000

510,000 830,000 255,000$

b.

SOLUTIONS TO PROBLEMS SET A

*Computation of retained earnings at December 31, 2011:

Common dividends ($0.75 x 170,000 shares x 4 years)Retained earnings, December 31, 2011

8% cumulative preferred stock, $100 par value,

PROBLEM 11.1A

ROBBINSVILLE PRESS

December 31, 2011Partial Balance Sheet

ROBBINSVILLE PRESS

There are no dividends in arrears at December 31, 2011. We know this because common dividends were paid in each of the four years that the company was in existence. Common shareholders could not have received dividends in each year of the company’s existence had any dividends been in arrears on the preferred stock.

Net income for the four-year period 2008-2011Less: Preferred dividends ($80,000 per year for four years)

Common stock, $1 par value, authorized 500,000 shares

Additional paid-in capital: Common stock

Retained earnings*

© The McGraw-Hill Companies, Inc., 2012P11.1A

20 Minutes, Easy

a.


authorized, issued, and outstanding 20,000 shares 2,000,000$

issued and outstanding 300,000 shares 300,000 5,700,000

Total paid-in capital 8,000,000$ 210,000

Total stockholders' equity 8,210,000$

4,460,000$ 1,000,000$

1,500,000 2,500,000 1,960,000$

Less: Net loss of 2011 1,750,000 210,000$

c. No. Dividends do not represent a liability of the corporation until they are declared by the board of directors.

PROBLEM 11.2A

WALLER PUBLICATIONS


WALLER PUBLICATIONS

b. Note to financial statements:As of December 31, 2011, dividends on the 10%, $100 par value, cumulative preferred stock were in arrears to the extent of $10 per share, amounting in total to $200,000.


Common stock, $1 par value, authorized 1 million shares,

Additional paid-in capital: common stock

Retained earnings*

Retained earnings, December 31, 2011

Common dividends ($1 x 300,000 shares x 5 years)Retained earnings, December 2010

Net income for the five-year period 2006-2010Less: Preferred dividends ($200,000 x 5 years)



25 Minutes, Medium

a.


shares authorized, issued, and outstanding 500,000$ $9 cumulative preferred stock, no-par value, 10,000 shares

authorized, 5,000 shares issued and outstanding 512,000

shares issued and outstanding 200,000 600,000

Total paid-in capital 1,812,000$ 640,000


Retained earnings at Dec. 31, 2009 170,000$ Add: Net income for 2010 and 2011 890,000

Net income for four-year period 1,060,000$ Less: Dividends paid on 8% preferred stock:

2009 ($40,000 in arrears) -$ 2010 ($40,000 in arrears for 2 years) 80,000

2011 (8% x $100 x 5,000 shares = $40,000) 40,000 (120,000) Dividends on $9 preferred stock:

2010 ($9 x 5,000 shares) $ 45,000 2011 ($9 x 5,000 shares) 45,000 (90,000)

Dividends on common stock:2010 ($0.50 x 100,000 shares) 50,000$ 2011 ($1.60 x 100,000 shares) 160,000 (210,000)

640,000$

b.

1.

2.

3.


Common stock, $2 par, 200,000 shares authorized, 100,000


Retained earnings*

Debt must be repaid at some future date. To be a permanent source of capital, debt must be periodically refinanced. Preferred stock generally does not mature.

Increasing the amount of debt on a balance sheet can adversely affect financial ratios.


A corporation might decide to use cumulative preferred stock rather than debt to finance operations for any of the following reasons (only 2 required):

Although cumulative dividends must eventually be paid if the corporation is profitable, they do not have to be paid each year and do not become a legal obligation of the corporation until they are declared. Interest on debt is a legal obligation of the corporation and must be paid each year.

8% cumulative preferred stock, $100 par, 5,000

PROBLEM 11.3A

MANHATTAN TRANSPORT COMPANY


MANHATTAN TRANSPORT COMPANY


35 Minutes, Medium

Jan 6 Cash 280,000 Common Stock 40,000

240,000

7 7,000

Common Stock 1,000 6,000

12 250,000 250,000

June 4 Land 225,000 Common Stock 30,000

195,000

Nov 15 25,000 25,000

Dec 20 25,000 Cash 25,000

31 Retained Earnings 147,200

147,200 year.

31 25,000 25,000

exchange for services relating to formation of the

Cash

Additional Paid-in Capital: Common Stock

DividendsTo close the Dividends account.

Retained Earnings

PROBLEM 11.4A

a.General Journal

BARNES COMMUNICATIONS, INC.

10% Cumulative Preferred Stock

Income Summary

Payable Dec. 20.

To record payment of dividend declared Nov. 15.

per share on 2,500 preferred shares outstanding.

Dividends Payable

for land valued at $225,000 (15,000 shares x $15).

Dividends (Preferred Stock)Dividends Payable

To record declaration of annual dividends of $10

20__

Issued 20,000 shares of $2 par value common stock Additional Paid-in Capital: Common Stock

Organization Costs Expense

at $14 per share.

Issued 15,000 shares of common stock in exchange

Issued 500 shares of common stock to Barnes inAdditional Paid-in Capital: Common Stock

Issued 2,500 shares of $100 par value, 10%,cumulative preferred stock at par value.

corporation. Implied issuance price ($7,000 ÷ 500shares) = $14 per share.

To close the Income Summary account for the


b.


50,000 shares, issued and outstanding 2,500 shares 250,000$

issued and outstanding 35,500 shares 71,000 441,000

Total paid-in capital 762,000$ 122,200

Total stockholders' equity 884,200$

-$ 147,200

(25,000) 122,200$

*Computation of retained earnings at December 31, 20xx:

Common stock, $2 par, authorized 400,000 shares,


Retained earnings*

10% cumulative preferred stock, $100 par, authorized

PROBLEM 11.4A

BARNES COMMUNICATIONS, INC.

December 31, 20xx___Partial Balance Sheet

BARNES COMMUNICATIONS, INC. (concluded)

Retained earnings at December 31, 20xx.

Retained earnings at January 1, 20xxAdd: Net income in 20xxLess: Preferred dividends in 20xx

© The McGraw-Hill Companies, Inc., 2012P11.4A (p.2)

35 Minutes, Strong

a. Par value of all preferred stock outstanding 2,400,000$ 100$

24,000

b. Dividend requirement per share of preferred stock (7 1/2% x $100) 7.50$ 24,000

Annual preferred stock dividend requirement ($7.50 x 24,000 shares) 180,000$

c. 900,000$ 2$

Number of shares of common stock outstanding ($900,000 ÷ $2 per share) 450,000

d. 900,000$ Paid-in capital in excess of par: Common 8,325,000

Total issuance price of all common stock 9,225,000$ Number of shares of common stock issued (c) 450,000

20.50$

e. 2,400,000$ 900,000

3,300,000$

f. 3,300,000$ 8,325,000

11,625,000$

g. Total stockholders’ equity 14,220,000$ Less: Par value of preferred stock [24,000 shares (a ) x $100 per share] 2,400,000

Equity of common stockholders 11,820,000$ Number of shares of common stock outstanding (c ) 450,000 Book value per share ($11,820,000 ¸ 450,000 shares) 26.27$

h. Retained earnings, beginning of the year 717,500$ Add: Net income for the year 3,970,000

Subtotal 4,687,500$ Less: Retained earnings, end of the year 2,595,000

Total dividends paid during the year 2,092,500$ Less: Dividends on preferred stock (part b ) 180,000

Total dividends on common stock 1,912,500$ Number of common shares outstanding 450,000

Dividends per share of common stock ($1,912,500 ¸ 450,000) 4.25$

Par value per share of common stockPar value of all common stock outstanding

Total legal capital (e)

Par value of all common stock issued

Add: Additional paid-in capital: Common stockTotal paid-in capital

Average issuance price per share of common ($9,225,000 ÷ 450,000 shares)

Par value of preferred stockPar value of common stock

Total legal capital

PROBLEM 11.5ASMITHFIELD PRODUCTS

Par value per share of preferred stock

Number of shares of preferred stock outstanding ($2,400,000 ÷ $100)

Number of shares of preferred stock outstanding (a)


35 Minutes, Medium

In Thousands (Except for Per Share Amounts) a. Par value of all common stock outstanding 6,819$

Par value per share 0.50 Number of shares outstanding ($6,819/$0.50) 13,638

b. Dividend requirement per share of preferred stock 17.20$

Numbers of shares of preferred stock outstanding 345 Annual dividends paid to preferred stockholders ($17.20 x 345) 5,934$

c. Par value of preferred stock 86,250$

Par value of common stock 6,819 Additional paid-in capital 87,260 Total paid-in capital 180,329$

d. Total stockholders’ equity 237,592$

Less: Preferred stock par value = ($250 x 345 shares) 86,250 Equity of common stockholders 151,342$ Number of shares of common stock outstanding 13,638 Book value per share ($151,342/13,638 shares) 11.10$

PROBLEM 11.6APARSONS, INC. CORPORATION


e.

f.

g.

PROBLEM 11.6A

The two principal factors that cause one preferred to yield less than another are: (1) the appearance of greater ability to pay the preferred dividends each year, and (2) special features that appeal to investors, such as Parson’s conversion feature, cumulative dividends, or a high call price.

PARSONS, INC. (concluded)

The basic advantage of being publicly owned is that the corporation has the opportunity to raise large amounts of equity capital from many investors. Some publicly owned corporations have millions of stockholders, including pension funds, mutual funds, and other corporations. Closely held corporations are usually unable to raise the large amounts of capital available to publicly owned corporations.

A major advantage to the stockholders of a publicly owned corporation is that theirequity investments are highly liquid assets, immediately salable at quoted marketprices.

The primary disadvantages of being publicly owned are the increased governmental regulations and financial reporting requirements.

The term convertible means that at the option of the preferred stockholder, each preferred share can be converted into a specified number of common shares. To evaluate the value of this conversion feature, the stockholder must know into how many shares of common each preferred share can be converted. This information is disclosed in the notes accompanying the corporation’s financial statements.

At $248 per share, Parson's preferred has a dividend yield of 6.9% ($17.20 ÷ $248). In comparison, an 8%, $50 par preferred selling at $57 has a dividend yield of 7% [(8% x $50 par) ÷ $57].

The dividend yield on preferred stock indicates how much investors value certainfeatures of the stock. The lower the yield, the more investors favor the stock. Ahigher yield means that investors demand a higher return to induce them to purchasethe stock.

© The McGraw-Hill Companies, Inc., 2012P11.6A(p.2)

15 Minutes, Easy

a.

b.

The market value of $65 is 10 times book value. This implies that investors believe that management and product lines make the company worth far more than the amounts of capital historically invested.

The very low par value offers little protection to the company’s creditors. On the other hand, a market value of many times book value implies that little cushion is required for creditors’ claims to be secure. If the company performs as its market price implies that it will, its earnings and cash flows should make the creditors’ positions quite secure. Earnings and cash flows are far more relevant to a company’s debt-paying ability than is the cushion provided by par value.

The market value of a share of stock is established in the marketplace. It represents the per-share price at which willing sellers can and will sell shares of the stock to willing buyers. Market value is related primarily to investors’ future expectations of the company’s performance, rather than to historical amounts.

The company’s par value—one-tenth of a cent per share—is quite low. However, thecorporation can set par value at any level that it chooses; the amount of par value hasno direct effect upon either book value or market value. It does mean, however, thatthe amount of the company’s legal capital—serving as a cushion for creditors—is quite low. Another reason for the small par value is the possibility of stock splits in the past.

The fact that book value per share ($6.50) is far above par value indicates either that (1) the stock initially was issued at a price far above par value, or (2) that the company has retained substantial amounts of earnings. Even if there had been stock splits in prior years, the total dollar amount of book value would not have been affected.

PROBLEM 11.7ATECHNO CORPORATION

Par value is the legal capital per share—the amount by which stockholders’ equity cannot be reduced except by losses. Thus, par value may be viewed as a minimum cushion of equity capital existing for the protection of creditors.

Book value per share is equal to the net assets represented by each share of commonstock. Book value is a historical cost concept, representing the amounts invested bythe stockholders, plus the amounts earned and retained by the corporation. Bycomparing book value with current market value, stockholders may gain insight intowhether management has increased or diminished the value of the resourcesentrusted to their care.


15 Minutes, Medium

Stockholders’ equity: Common stock, $1 par, 50,000 shares authorized, issued, and 50,000$ outstandingAdditional paid-in capital: Common stock 350,000 Additional paid-in capital: Treasury stock 5,000

Total paid-in capital 405,000$ Retained earnings* 185,000

Total stockholders’ equity 590,000$

*Computation of retained earnings at Dec. 31, 2011: Net income in 2009 82,000$ Net income in 2010 25,000 Net income in 2011 78,000 Retained earnings, Dec. 31, 2011 185,000$

b.

c. The treasury stock purchase of $35,000 in 2010 was reported as a financing cash outflow in the statement of cash flows for that year. The reissue of the treasury stock for $40,000 in the following year was reported as a financing cash inflow in the 2011 statement of cash flows.

The company’s book value per share is $11.80 ($590,000 total stockholders’ equity ÷ 50,000 shares outstanding).

PROBLEM 11.8A

a.

FELLER CORPORATION


30 Minutes, Strong

Stockholders’ equity: 10% preferred stock, $100 par, cumulative, authorized, issued, and outstanding 30,000 shares 3,000,000$ Common stock, $10 par, 200,000 shares authorized, 120,000 shares issued, of which 10,000 shares are held in treasury 1,200,000 Additional paid-in capital: Common stock 720,000 Additional paid-in capital: Treasury stock* 50,000

Total paid-in capital 4,970,000$ Retained earnings** 1,925,000

Subtotal 6,895,000$ Less: Treasury stock (10,000 shares x $20 cost per share) 200,000

Total stockholders’ equity at Dec. 31, 2011 6,695,000$

*Computation of additional paid-in capital on treasury stock: Purchase price per share: $400,000 ÷ 20,000 shares = $20 per shareReissue price per share: $250,000 ÷ 10,000 shares = $25 per sharePaid-in capital per share reissued: $5 per share ($25 - $20) Total paid-in capital on treasury stock: $50,000 ($5 per share x 10,000 shares reissued)

**Computation of retained earnings at Dec. 31, 2011: Net income (for years 2007–2011) 3,700,000$ Net in Preferred dividend (for years 2007–2011)

$100 x 10% x 30,000 shares x 5 years 1,500,000$ Less: Common dividends

2007–2008: 120,000 shares outstanding x $0.50 x 2 yrs 120,000 2009–2010: 100,000 shares outstanding x $0.50 x 2 yrs 100,000 2011: 110,000 shares outstanding x $0.50 55,000 1,775,000

Retained earnings, Dec. 31, 2011 1,925,000$

b.

c.

The company’s book value per share is approximately $33.59 ($6,695,000 total stockholders’ equity $3,000,000 of preferred stock = $3,695,000; $3,695,000 ÷ 110,000 shares outstanding = $33.59).

Had the company decided to split its common stock 3-for-1 on December 31, 2011, the market value would have fallen to approximately $10 per share ($30 ÷ 3). The par value would have been reduced to $3.33 ($10 ÷ 3), and the number of shares outstanding would have increased to 330,000 shares (110,000 x 3).

PROBLEM 11.9A

a.

HERNDON INDUSTRIES


mailto:=@sum(g35.g39)�

20 Minutes, Easy

a.


at $110, authorized 1,000 shares, issued and out- 50,000$ standing 500 shares

Issued and outstanding 80,000 shares 80,000

1,120,000 Total paid-in capital 1,250,000$

1,652,000 Total stockholders' equity 2,902,000$

1,800,000$ $ 20,000

128,000 148,000 1,652,000$

b.

c. The market price of preferred stock usually decreases as interest rates increase. Thus, at December 31, 2011, the market price of Septa's preferred stock was probably lower than its call price of $110 (in fact, it may actually have fallen below its original price of $100 per share).


Common stock, $1 par value, authorized 200,000 shares


Retained earnings*

Common dividends ($0.40 x 80,000 shares x 4 years)Retained earnings, December 31, 2011

Net income for the four-year period 2008-2011Less: Preferred dividends ($5,000 per year for four years)

There are no dividends in arrears at December 31, 2011 We know this because common dividends were paid in each of the four years that the company was in existence. Common shareholders could not have received dividends in each year of the company’s existence had any dividends been in arrears on the preferred stock.

10% cumulative preferred stock, $100 par value, callable

SOLUTIONS TO PROBLEMS SET BPROBLEM 11.1B

SEPTA, INC.


SEPTA, INC.

© The McGraw-Hill Companies, Inc., 2012P11.1B

20 Minutes, Easy

a.


authorized, issued, and outstanding 10,000 shares 1,000,000$

issued and outstanding 400,000 shares 400,000 5,600,000$

Total paid-in capital 7,000,000 900,000


4,100,000$ $ 500,000

1,600,000 2,100,000 2,000,000$

Less: Net loss of 2011 1,100,000 900,000$

c.


Common stock, $1 par value, authorized 1 million shares,

Additional paid-in capital: common stock

PROBLEM 11.2B

BANNER PUBLICATIONS


BANNER PUBLICATIONS


No. Dividends do not represent a liability of the corporation until they are declared by the board of directors.

Retained earnings*

b. Note to financial statements:As of December 31, 2011, dividends on the 10%, $100 par value, cumulative preferred stock were in arrears to the extent of $10 per share, amounting in total to $100,000.


Common dividends ($.80 x 400,000 shares x 5 years)Retained earnings, December 2010

Net income for the five-year period 2006-2010Less: Preferred dividends ($100,000 x 5 years)


25 Minutes, Medium

a.


shares authorized, issued, and outstanding 1,000,000$ $6 cumulative preferred stock, no-par value, 8,000 shares

authorized, 5,000 shares issued and outstanding 320,000

shares issued and outstanding 130,000 1,820,000

Total paid-in capital 3,270,000$ 1,193,000


Retained earnings at Dec. 31, 2009 530,000$ Add: Net income for 2010 and 2011 1,400,000

Net income for four-year period 1,930,000$ Less: Dividends paid on 10% preferred stock:

2009 ($100,000 in arrears) -$ 2010 ($100,000 in arrears for 2 years) 200,000

2011 (10% x $100 x 10,000 shares = $100,000) 100,000 (300,000) Dividends on $6 preferred stock:

2010 ($6 x 5,000 shares) $ 30,000 2011 ($6 x 5,000 shares) 30,000 (60,000)

Dividends on common stock:2010 ($0.90 x 130,000 shares) 117,000$ 2011 ($2.00 x 130,000 shares) 260,000 (377,000)

1,193,000$

b.

1.

2.

3.

PROBLEM 11.3B

RAY BEAM, INC.


RAY BEAM, INC.

10% cumulative preferred stock, $100 par value, 10,000

Common stock, $1 par, 260,000 shares authorized, 130,000


Retained earnings*


Debt must be repaid at some future date. To be a permanent source of capital, debt must be periodically refinanced. Preferred stock generally does not mature.

Increasing the amount of debt on a balance sheet can adversely affect financial ratios.


A corporation might decide to use cumulative preferred stock rather than debt to finance operations for any of the following reasons (only 2 required):

Although cumulative dividends must eventually be paid if the corporation is profitable, they do not have to be paid each year and do not become a legal obligation of the corporation until they are declared. Interest on debt is a legal obligation of the corporation and must be paid each year.


35 Minutes, Medium

Jan 7 Cash 300,000 Common Stock 30,000

270,000

12 12,000

Common Stock 1,000 11,000

18 400,000 400,000

July 5 Land 120,000 Common Stock 10,000

110,000

Nov 25 20,000 20,000

Dec 11 20,000 Cash 20,000

31 Retained Earnings 810,000

810,000 year.

31 20,000 20,000 Dividends (Preferred Stock)

To close the Income Summary account for the

To record payment of dividend declared Nov. 25.

Dividends Payable

Organization Costs Expense

at $10 per share.

Income Summary

Payable Dec. 11.


exchange for services relating to formation of the

for land valued at $120,000 (10,000 shares x $12).


Issued 4,000 shares of $100 par value, 5%,cumulative preferred stock at par value.

To close the Dividends account.

Retained Earnings

To record declaration of annual dividends of $5

Dividends (Preferred Stock)

PROBLEM 11.4B

a.General Journal

MARKUP, INC.

Issued 30,000 shares of $1 par value common stock Additional Paid-in Capital: Common Stock

Dividends Payable

Issued 10,000 shares of common stock in exchange

20__

per share on 4,000 preferred shares outstanding.

Issued 1,000 shares of common stock to Deal in

corporation. Implied issuance price ($12,000 ÷ 1,000shares) = $12 per share.

5% Cumulative Preferred StockCash


20 Minutes, Easy

b.


100,000 shares, issued and outstanding 4,000 shares 400,000$

issued and outstanding 41,000 shares 41,000 391,000

Total paid-in capital 832,000$ 790,000


-$ 810,000

(20,000) 790,000$

Retained earnings at December 31, 20xx.

Retained earnings at January 1, 20xxAdd: Net income in 20xxLess: Preferred dividends in 20xx

5% cumulative preferred stock, $100 par, authorized

PROBLEM 11.4B

MARKUP, INC.

December 31, 20xxPartial Balance Sheet

MARKUP, INC. (concluded)


Retained earnings*

*Computation of retained earnings at December 31, 20xx:

Common stock, $1 par, authorized 100,000 shares,

© The McGraw-Hill Companies, Inc., 2012P11.4B (p.2)

35 Minutes, Strong

a. Par value of all preferred stock outstanding 4,400,000$ 100$

44,000

b. Dividend requirement per share of preferred stock (10% x $100) 10$ 44,000

Annual preferred stock dividend requirement ($10 x 44,000 shares) 440,000$

c. 3,400,000$ 2$

Number of shares of common stock outstanding ($3,400,000 ÷ $2 per share) 1,700,000

d. 3,400,000$ Paid-in capital in excess of par: Common 6,800,000

Total issuance price of all common stock 10,200,000$ Number of shares of common stock issued (c) 1,700,000

6$

e. 4,400,000$ 3,400,000

7,800,000$

f. 7,800,000$ 6,800,000$

Donated capital 400,000 15,000,000$

g. Total stockholders’ equity 18,160,000$ Less: Par value of preferred stock [44,000 shares (a ) x $100 per share] 4,400,000

Equity of common stockholders 13,760,000$ Number of shares of common stock outstanding (c ) 1,700,000 Book value per share ($13,760,000 ÷ 1,700,000 shares) 8.09$

h. Retained earnings, beginning of the year 1,200,000$ Add: Net income for the year 4,800,000

Subtotal 6,000,000$ Less: Retained earnings, end of the year 3,160,000

Total dividends paid during the year 2,840,000$ Less: Dividends on preferred stock (part b ) 440,000

Total dividends on common stock 2,400,000$ Number of common shares outstanding 1,700,000

Dividends per share of common stock ($2,400,000 ÷ 1,700,000) 1.41$

PROBLEM 11.5BMANOR, INC.

Par value per share of common stockPar value of all common stock outstanding

Par value of all common stock issued

Par value per share of preferred stock

Number of shares of preferred stock outstanding ($4,400,000 ÷ $100)

Number of shares of preferred stock outstanding (a)

Total legal capital (e)

Total paid-in capital

Average issuance price per share of common ($10,200,000 ÷ 1,700,000 shares)

Par value of preferred stockPar value of common stock

Total legal capital

Add: Additional paid-in capital: Common stock


35 Minutes, Medium

In Thousands (Except for Per Share Amounts) a. Par value of all common stock outstanding 9,600$

Par value per share 3$ Number of shares outstanding ($9,600/$3) 3,200

b. Dividend requirement per share of preferred stock 10$

Numbers of shares of preferred stock outstanding 250 Annual dividends paid to preferred stockholders ($10 x 250) 2,500$

c. Par value of preferred stock 50,000$

Par value of common stock 9,600$ Additional paid-in capital 76,800 Total paid-in capital 136,400$

d. Total stockholders’ equity 187,000$

Less: Preferred stock par value = ($200 x 250 shares) 50,000 Equity of common stockholders 137,000$ Number of shares of common stock outstanding 3,200 Book value per share ($137,000 ÷ 3,200 shares) 42.81$

PROBLEM 11.6BTOASTY CORPORATION


e.

f.

g.

The two principal factors that cause one preferred to yield less than another are: (1) the appearance of greater ability to pay the preferred dividends each year, and (2) special features that appeal to investors, such as Toasty’s conversion feature, cumulative dividends, or a high call price.

At $190 per share, Toasty’s preferred has a dividend yield of 5.26% ($10 ÷ $190). In comparison, a 6%, $50 par preferred selling at $52 has a dividend yield of 5.77% [(6% x $50 par) ÷ $52].

The basic advantage of being publicly owned is that the corporation has the opportunity to raise large amounts of equity capital from many investors. Some publicly owned corporations have millions of stockholders, including pension funds, mutual funds, and other corporations. Closely held corporations are usually unable to raise the large amounts of capital available to publicly owned corporations.

A major advantage to the stockholders of a publicly owned corporation is that their equity investments are highly liquid assets, immediately salable at quoted market prices.

The primary disadvantages of being publicly owned are the increased governmental regulations and financial reporting requirements.

PROBLEM 11.6BTOASTY CORPORATION (concluded)

The term convertible means that at the option of the preferred stockholder, each preferred share can be converted into a specified number of common shares. To evaluate the value of this conversion feature, the stockholder must know into how many shares of common each preferred share can be converted. This information is disclosed in the notes accompanying the corporation’s financial statements.

The dividend yield on preferred stock indicates how much investors value certain features of the stock. The lower the yield, the more investors favor the stock. A higher yield means that investors demand a higher return to induce them to purchase the stock.

© The McGraw-Hill Companies, Inc., 2012P11.6B(p.2)

15 Minutes, Easy

a.

b.

The fact that book value per share ($10.00) is far above par value indicates either that (1) the stock initially was issued at a price far above par value, or (2) that the company has retained substantial amounts of earnings. Even if there had been stock splits in prior years, the total dollar amount of book value would not have been affected.

PROBLEM 11.7BBRAIN CORPORATION

The very low par value offers little "cushion" to the company’s creditors. On the other hand, a market value of many times book value implies that little cushion is required for creditors’ claims to be secure. If the company performs as its market price implies that it will, its earnings and cash flows should make the creditors’ positions quite secure. Earnings and cash flows are far more relevant to a company’s debt-paying ability than is the cushion provided by par value.

Par value is the legal capital per share—the amount by which stockholders’ equity cannot be reduced except by losses. Thus, par value may be viewed as a minimum cushion of equity capital existing for the protection of creditors.

Book value per share is equal to the net assets represented by each share of common stock. Book value is a historical cost concept, representing the amounts invested by the stockholders, plus the amounts earned and retained by the corporation. By comparing book value with current market value, stockholders may gain insight into whether management has increased or diminished the value of the resources entrusted to their care.

The market value of $96 is 9.6 times book value. This implies that investors believe that management and product lines make the company worth far more than the amounts of capital historically invested.

The market value of a share of stock is established in the marketplace. It represents the per-share price at which willing sellers can and will sell shares of the stock to willing buyers. Market value is related primarily to investors’ future expectations of the company’s performance, rather than to historical amounts.

The company’s par value—five cents per share—is quite low. However, the corporation can set par value at any level that it chooses; the amount of par value has no direct effect upon either book value or market value. It does mean, however, that the amount of the company’s legal capital—serving as a cushion for creditors—is quite low. Another reason for the small par value is the possibility of stock splits in prior years.


15 Minutes, Medium

Stockholders’ equity: Common stock, $3 par, 50,000 shares authorized, issued, an 150,000$

outstandingAdditional paid-in capital: Common stock 350,000 Additional paid-in capital: Treasury stock 10,000

Total paid-in capital 510,000$ Retained earnings* 330,000

Total stockholders’ equity 840,000$

*Computation of retained earnings at Dec. 31, 2011: Net income in 2009 150,000$ Net income in 2010 80,000 Net income in 2011 100,000 Retained earnings, Dec. 31, 2011 330,000$

b.

c. The treasury stock purchase of $30,000 in 2010 was reported as a financing cash outflow in the statement of cash flows for that year. The reissue of the treasury stock for $40,000 in the following year was reported as a financing cash inflow in the 2011 statement of cash flows.

The company’s book value per share is $16.80 ($840,000 total stockholders’ equity ÷ 50,000 shares outstanding).

PROBLEM 11.8B

a.

TIN CORPORATION


30 Minutes, Strong

Stockholders’ equity: 6% preferred stock, $100 par, cumulative, authorized and issued and outstanding 10,000 shares 1,000,000$ Common stock, $20 par, 100,000 shares authorized, 80,000 shares issued, of which 400 shares are held in treasury 1,600,000 Additional paid-in capital: Common stock 1,200,000 Additional paid-in capital: Treasury stock* 6,000

Total paid-in capital 3,806,000$ Retained earnings** 3,261,440

Subtotal 7,067,440 Less: Treasury stock (400 shares x $40 cost per share) 16,000

Total stockholders’ equity at Dec. 31, 2011 7,051,440$

*Computation of additional paid-in capital on treasury stock: Purchase price per share: $40,000 ÷ 1,000 shares = $40 per shareReissue price per share: $30,000 ÷ 600 shares = $50 per sharePaid-in capital per share reissued: $10 per share ($50 - $40) Total paid-in capital on treasury stock: $6,000 ($10 per share x 600 shares reissued)

**Computation of retained earnings at Dec. 31, 2011: Net income (for years 2007–2011) 3,800,000$ Less: Preferred dividend (for years 2007–2011)

$100 x 6% x 10,000 shares x 5 years 300,000 Less: Common dividends

2007–2008: 80,000 shares outstanding x $0.60 x 2 yrs 96,000$ 2009–2010: 79,000 shares outstanding x $0.60 x 2 yrs 94,800 2011: 79,600 shares outstanding x $0.60 47,760 238,560

Retained earnings, Dec. 31, 2011 3,261,440$

b.

c.

The company’s book value per share is approximately $76.02 ($7,051,440 total stockholders’ equity $1,000,000 of preferred stock book value = $6,051,440; $6,051,440 ÷ 79,600 shares outstanding = $76.02).

Had the company decided to split its common stock 2-for-1 on December 31, 2009, the market value would have fallen to approximately $28 per share ($56 ÷ 2). The par value would have been reduced to $10.00 ($20 ÷ 2), and the number of shares outstanding would have increased to 159,200 shares (79,600 x 2).

PROBLEM 11.9B

a.

PARKER INDUSTRIES


mailto:=@sum(g35.g39)�

15 Minutes, Medium

a.

b.

c. The market price of the 7%, $100 par value convertible preferred stock should rise approximately in proportion to the increase in the market value of the common stock. This issue of preferred stock is already deriving much of its market value from its conversion feature, as indicated by the fact that its market price ($125) exceeds the market price of ADM’s 10% preferred stock ($90), which pays a higher dividend.

The current market price of the convertible preferred stock is too high to be explained by its $7 per year dividend, and it is approximately three times the current market price of the common stock. Therefore, each share of this preferred stock probably is convertible into about three shares of common stock. As the market price of the common stock increases, the market price of the convertible preferred should also increase to remain approximately equal in value to three shares of common stock.

The market price of the 10%, $100 par value preferred stock may be expected to decline gradually as long-term interest rates rise. The market price of preferred stock tends to vary inversely with the level of interest rates.

SOLUTIONS TO CRITICAL THINKING CASES

FACTORS AFFECTING THE MARKET PRICESCASE 11.1

If ADM’s profitability increases dramatically, the market price of its common stock probably will rise significantly. The improved profitability of the company may lead to larger increases in the dividends paid to common stockholders than the 5 and 10 cent increases of prior years. The market price of common stock is strongly affected by such factors as the company’s expected future earnings and the probable rate of future common stock dividends.

OF PREFERRED AND COMMON STOCKS

© The McGraw-Hill Companies, Inc., 2012Case 11.1

25 Minutes, Strong

OF COMMON STOCKS

a.

b.

c.

CASE 11.2

The visit by the Federal Drug Administration signaled to the market that Ventitex may be having problems with approval for one or more of its products. If approval is denied, the company will not be able to sell the products. Therefore, investors are reducing their expectations of the company’s future earnings and increasing their assessments of the risk of the business. This caused the stock price to drop.

The value of a share of common stock is based on investors’ expectations about future earnings and cash flows of the business. Thus, the increase in the price of the shares of McDonnell Douglas resulted from an increase in investors’ expectations about future earnings of the company based on this large order by Saudia Airlines.

The fall in the price of Citicorp’s common stock probably is based on two factors. The increase in the discount rate by the Federal Reserve Board signals a general increase in interest rates which will affect the required yield on all investments. Since investors will demand a higher yield on their investments, stock and bond prices may suffer an overall decline.

As a financial institution, this increase in the discount rate has additional significance to Citicorp. The increase in the discount rate increases Citicorp’s cost of funds, which will reduce its net income, at least in the short run. This reduction in expectations about future earnings will further reduce the bank’s stock price.

FACTORS AFFECTING THE MARKET PRICES


Group assignment:

No time estimate

CASE 11.3

• Among the “unforeseen complications” that often come to light are the problems when partners do not see eye to eye, and the costs and complications resulting from the corporation being a taxable entity.

• The normal reason why a business may change its form of entity is to attract more capital.

• Some students may encounter professional corporations, which often are used by one or more members of a partnership. These professional corporations are intended to limit the individuals’ personal liability—although they require the individual to carry “malpractice” insurance and do not exonerate them from liability for some types of professional misconduct. They may also encounter S corporations, which, for tax purposes, are treated as unincorporated organizations.

SELECTING A FORM OF ORGANIZATION

We do not provide comprehensive solutions for group problems that involve interviews. But the following items normally come to light in our classes.

• Students may find that many people entered a business without giving much thought to the form of entity.


20 Minutes, Medium

(a)

(b)

(c)

(d)

••••••

CASE 11.4S.E.C. ENFORCEMENT DIVISION

Corporate Finance

The Division of Enforcement investigates possible violations of securities laws, recommends Commission action when appropriate, either in a federal court or before an administrative law judge, and negotiates settlements.

The publication is Pump & Dump.com: Tips for Avoiding Stock Scams on the Internet.

EnforcementInvestment ManagementMarket Regulation

Always be skeptical

ETHICS, FRAUD & CORPORATE GOVERNANCE

Independently verify the claims that are made about the stockResearch the investment opportunityWatch out for high-pressure pitches to invest

The four divisions of the Securities and Exchange Commission are:

A pump & dump scheme works as follows. A company's web site may feature a glowing press release about its financial performance or some other aspect of the company, such as a new product or innovation. Newsletters that purport to offer unbiased recommendations may tout the company as the latest "hot" stock. Messages in chat rooms and bulletin board postings urge people to buy stock quickly or to sell before the price goes down. Uninformed investors then purchase the stock in large numbers, pushing up the price of the stock. Then the fraudsters behind the scheme sell their shares at the peak price and stop hyping the stock, which results in a rapid drop in stock price. Investors lose some or all of their investment.

The S.E.C. suggests investors consider the following to avoid such schemes:Consider the sourceFind out where the stock trades


30 Minutes, Easy

a.

b.

c.

[NOTE: The numbers in parts b. and c. will vary depending on the most recent balance used to answer these questions.]

The company’s balance sheet dated February 2, 2008 reports 162,728,588 shares of stock held in treasury at a total cost of $3,272,773 thousand. This represents an increase from 130,605,591 shares, costing $2,511,796 thousand, one year earlier.

EXAMINING STOCKHOLDERS' EQUITYCASE 11.5

The company’s balance sheet dated February 2, 2008, reports that five million shares of $0.01 par preferred stock have been authorized. However, as of this date, none of these shares has been issued.

The company has one classification of common stock: Staples, Inc. Stock

2,100,000 shares are authorized. At February 2, 2008, 867,336,103 shares had been issued and at February 3, 2007, 849,338,568 shares had been issued. The par value of each share is $.0006.

INTERNET


overview of brief exercises, exercises, …unieducation.yolasite.com/resources/chap011.pdf · brief...

Documents